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BREACH OF A DIRECTORS FIDUCIARY DUTY: THE SOFT LAW APPROACH AGAINST HARD LAW APPROACH

January 12th, 2011 by admin

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BY: NUR AZIMUL AZAMI

The collapse of multi-billion corporate entities such an Enron Corporation and Bear Stearns Incorporated shocked the world business community. It demonstrated an array of conflicts between the top management and the corporation at the cost of shareholders. The conflict as in the above cases is usually caused as a result of a director’s or a top management’s breach of his fiduciary duties to the company.

As a result of this many legislation and fixes were introduced not only in the United Stated but all over the world to ensure that such a catastrophe never occurred again in the corporate realm. Legislations were enacted to impose criminal sanction for a director’s breach of their fiduciary duties. In addition to the penal sanctions, many jurisdictions also created a code of corporate governance as a guidance of best practices that a company or director should adopt when running its business. This being said however, unlike the criminal measures adopted which is mandatory; a corporate governance code is voluntary in nature. Thus a breach of a director’s fiduciary duty in most jurisdictions’ corporate governance code of conduct does not entail any ramifications. The Malaysian Code on Corporate Governance does not contain any remedy for a director’s breach of his fiduciary duty though it specifies a best practice outline for director’s of a company. The Malaysian Code of Corporate Governance was created with the aim to set out principles and best practices on structures and processes that companies may use in their operations towards achieving the optimal governance framework.[1] The Code was principally an initiative of the private sector.

The need for a Code was inspired in part by a desire for the private sector to initiate and lead a review and to establish reforms of standards of corporate governance. However unlike the Malaysian Companies Act 1950 (Amendment 2007), our Code of Corporate Governance does not contain a provision that punishes a director for breaching his fiduciary duty to a company. Exclusion of such a provision could be understood in terms of the fact that the code was meant to be a soft law approach towards the issue of corporate governance (i.e. director’s duty). Government intervention in the regulation of markets and policing corporations, particularly through the use of criminal sanctions, has not been popular in recent years.[2] It is said that the use of criminal sanctions to a director’s conduct is perceived to be an overreaction that is likely to discourage directors from taking the risk that is necessary to run a business, thereby slowing down economic growth and interfering with profitability.

The code was based on a concept of self regulation by the industry to achieve corporate transparency, fairness and deter conflicts of interest between a director and a company. However such a concept of the code had two particular flaws, firstly in that compliance to it is voluntary and secondly there is no provision with regards to a director’s fiduciary duties and the consequence of breaching such duties. With regards to the latter, an insertion of such a provision is very important for the fact that as many countries move towards a self regulation model rather than government led regulation there must be an affirmative method of compliance on a director’s duty within the self-regulation framework itself. The code did not see it as important to impose further duties and obligations of directors but only sought to clarify their duties and obligations in such a way that directors are made to take notice of and understand their obligations.

It would be a little naïve to believe that all directors after understanding their true obligation would humbly submit and adhere to such obligations of the code without some form of coercion. Although it is foreseen that some may argue and state that the criminal sanctions provided for under the Malaysian Company Law 1950 is adequate in providing for a remedy for a director’s breach of his fiduciary duty there are others who argue that the use of criminal sanctions is an expansive way of enforcing regulations.[3] The latter view is very relevant based on the fact that criminal investigation and criminal litigation on commercial/corporate matters can take a very long time.

Another main issue is with regards to the effectiveness of using criminal sanctions to punish a director’s breach of his fiduciary duties. Even though much has been done to improve the awareness of corporate governance in Malaysia, the reality is that the lax enforcement of laws on directors and officials of listed companies in Malaysia remains a major setback.[4] The most oft-cited observation is that hardly any director of a listed company has been put behind bars.[5] This statement is true in a sense that section 132(3) provides either imprisonment or fine for a director in breach of provisions set out under section 132 of the Malaysian Companies Act. In most cases only fines are meted out. Lee Leok Soon of the Minority Shareholder Watchdog Group (MSWG) had this to say on such matters:

“Fines on directors are not a deterrent. It is like having to pay a fine for a traffic offences…as a result of this state of affairs, many transgressions and questionable deals that have taken place in the capital market involving companies such as Idris Hydraulic (M) Bhd, Repco Holdings Bhd, Ekran Bhd and Renong Corp Bhd, have not resulted in any individual being put behind bars.”

To a drastic extent, it may not even be wrong to suggest that the provisions under section 132 with regards to a director’s breach of his fiduciary duties is a dead letter law since it is rarely used against a director. Such assertions are not without basis as Rita Benoy Bushon head of the Shareholder Watchdog Group (MSWG) had said:

“It is puzzling that there has hardly been any prosecution of directors of listed companies based on this provision…In all the shenanigans that have taken place in listed companies in Malaysia, it seems odd that not a single director has been found guilty of breach of his or her fiduciary duty under Section 132 of the Companies Act.”[6]

Besides this, there is also the concern with regards to the burden of proof in a criminal trial. Assoc-Prof Mak Yuen Teen notes that there is sometimes the concern that it is difficult to prove such cases in court.[7] In charging a company director for breach of fiduciary duties, Mak, who is with the National University of Singapore’s accounting department, adds however that it is the duty of the regulator to still try to prosecute directors who have done wrong. Pursuing company directors for failure of discharging their fiduciary duties sends out the right deterrent message to directors. In April 2010 a new provision in the Capital Market Services Act (CMSA) came into force. Section 317A gave the Securities Commission the powers to go after directors for failing to discharge their fiduciary duties. The section carries a punishment of a fine of up to RM10mil and imprisonment of up to 10 years

Although such provisions can be applauded as it shows the commitment of the government to address the issue of a company’s director’s misconduct, a lingering question that still emerges is whether there can be effective enforcement. Yes the punishment set out is heavier but is it really effective in the long run. This being said, the author believes that sometimes we become too concerned with statutory provisions that we tend to ignore other sources that could be an effective mechanism to enforce compliance against a director’s breach of his fiduciary duties. One such source that could be used to enforce rights against a director who breaches his fiduciary duty is the Malaysian Code of Corporate Governance

[1] The Malaysian Code of Corporate Governance (Revised 2007) accessed at www.sc.com.my on 19 October 2010

[2] M. Lois, “Why Criminal Sanctions Still Matters.” International Company and Commercial Law Review. Pg 2

[3] X. Tang, “Revisions of Laws and Corporate Governance in China.” Berkeley Centre for Law and Business.

14 Responses to “BREACH OF A DIRECTORS FIDUCIARY DUTY: THE SOFT LAW APPROACH AGAINST HARD LAW APPROACH”

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